There were 10,621 new personal insolvencies between 2020 and 2021, of which 6,792 were bankruptcies. Financial difficulty, insolvency, and bankruptcy are among the most stressful events in life that many of us hope to avoid. Whether you’re experiencing a personal financial struggle or through your business, bankruptcy may be the final destination.
If such financial difficulties aren’t stressful enough, the situation may seem dire when ATO comes calling. Don’t worry; we’ll explain everything you need to know about bankruptcy and tax.
Consequences of bankruptcy
Bankruptcy might provide relief from insolvency. However, it isn’t a get out of jail free solution. Filing for bankruptcy may result in the following consequences:
- You may need to make compulsory payments which can affect your income, employment and business.
- You might have to seek permission from your trustee to travel overseas.
- Your name will permanently go on the National Personal Insolvency Index (NPII).
- It might affect your ability to apply for credit in the future.
- Bankruptcy does not clear all debts—it may not cover Australian Taxation Office debts.
How does bankruptcy affect your taxes?
Bankruptcy occurs either through voluntary action or filed by a creditor if you cannot pay your debts. Once declared, a trustee will manage your affairs, potentially disposing of your assets to pay debts. You might have to make regular payments from any income you earn.
Bankruptcy usually lasts three years and one day from the day the Australian Financial Security Authority accepts your form.
You must contact the ATO to declare insolvency—or your trustee might declare bankruptcy on your behalf. Once aware of your bankruptcy status, the ATO will add the amount you should have paid to your previous income tax debts. You should speak to a professional tax advisor or trustee about your tax obligations.
Does bankruptcy clear tax debt in Australia?
Generally speaking, tax is not exempt from bankruptcy. You’ll need to confirm with the ATO whether bankruptcy clears your tax debts or not. Typically, your debts will include all income tax debts from previous financial years and the tax you should pay in the current tax year.
ATO may retain the funds to offset the outstanding debt if you receive any tax refunds during your bankruptcy. After your bankruptcy period, the ATO cannot recover any remaining tax debts.
You’ll still need to lodge a tax return, as usual. Speak to your advisor or trustee about how you should complete the return. If you receive a refund on tax paid before bankruptcy, your trustee will claim it as an asset of your bankrupt estate. Therefore, it’s subject to paying your creditors.
Your trustee will treat it as income if you receive a tax refund relating to tax paid during bankruptcy. If the ATO is your creditor, they may retain the refund. Once discharged from bankruptcy, you may keep any tax refunds.
It’s in your best interest to lodge a tax return as soon as possible. The ATO will perform a default assessment on your tax debt if you’re behind, which is unlikely to be favourable or accurate.
Capital gains tax
During bankruptcy, your trustee will probably dispose of some of your assets to clear debts. Selling property or assets triggers Capital Gains Tax. Even if the trustee completes the action, the CGT law treats the disposal as yours. Therefore, you’re liable for CGT and must record the asset sale on your tax return.
What if you run a business?
Company directors cannot go bankrupt—only individuals or sole traders. Regardless of your bankruptcy status, you will still have to lodge BAS statements. If your company reaches insolvency, the ATO might send a director penalty notice (DPN). This makes you personally liable for the company’s tax debts, including:
- Pay As You Go (PAYG)
- Superannuation Guarantee Charge (SGC) liabilities
- Goods and services tax (GST)
Understanding your tax obligations while bankrupt is vital. If you don’t lodge your tax returns, you may owe more tax debts than strictly accurate. If you’re considering bankruptcy, ensure you lodge any outstanding returns and understand what you owe.